As many predicted, Congress managed to pass a bill that eliminates tax increases for the middle class while only minimally addressing federal budget and deficit issues.
The best economists can say about the deal is that it could have been worse. After all, there are many issues that have yet to be addressed because the can was essentially kicked down the road.
Here are the particulars of the deal and a brief summary of what they mean.
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First, the particulars.
- Tax rates for those making over $450,000 will revert permanently to a top 39.6% tax rate and a capital gains rate of 20%. Current tax rates—both income and capital gains rates—will become permanent for those earning less than the threshold amount.
- The estate tax will rise to 40% and the $5 million exemption will stay for those above the threshold and the threshold will be indexed to inflation.
- The sequester will be extended for two months. Discretionary cuts, both military and non-military, will offset half of the delay. Revenues raised by the voluntary rollover of regular IRAs to Roths will cover the other half.
- The Congressional pay freeze will be reinstated. The Earned Income Tax Credit, the Child Tax Credit, and the American Opportunity Tax Credit are all extended for five years.
- The Alternative Minimum Tax (AMT) will be patched permanently to prevent middle class taxpayers from becoming subject.
- The payroll tax holiday will expire and the debt ceiling has not yet been addressed.
- All temporary business tax breaks will be extended for another year as will specific cuts to doctors under Medicare.
- Unemployment insurance will also be extended for another year and the farm bill will be patched for nine months.
Very briefly, what the provisions mean:
The deal will essentially raise taxes on 77% of taxpayers because the payroll tax holiday is over, increasing most wage earners’ taxes by 2% since the payroll tax reverted back to 4.2% from 6.2%.
More details of the deal will be worked out over the rest of this week and Congress has two more months to come up with spending reductions. But the deal only delays major components of the fiscal cliff and budget deficit reductions.
The best news is that the AMT has received a permanent patch. And wealthy clients can breath a sigh of relief about the estate tax.
At least at this point, we can say there has been some sort of bipartisan agreement. Both sides are unhappy about some components and happy about others. Isn't that what compromise is all about?
You also now have more specific guidance to use in advising your clients. It may not be the guidance you wished for, but it indeed results in a bit less uncertainty. And the markets will certainly like that.
But the kicking of the can also means that 2013 should be a very interesting year
for investors and those trying to navigate the economic landscape.